2 September 1999 GST/HST Interpretation HQR0001844 - Bad Debts and Conditional Sales

Dear Sir:

Thank you for your letter of June 7, 1999 (with attachments) concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to your operations.

Statement of Facts

The following facts were provided in your letter:

1. ABC Company ("ABC") is a Canadian resident company and a GST registrant. ABC's commercial activities consist of leasing and/or financing tangible personal property in Canada. ABC files its GST return on a monthly basis.

2. XYZ Company ("XYZ") is a Canadian resident company and a GST registrant, XYZ's commercial activities consist of manufacturing furniture.

3. XYZ wants to purchase a new forklift for use in its commercial activities in Canada.

4. ABC agrees to sell a new forklift to XYZ and to provide XYZ with the necessary financing to purchase the forklift. To facilitate the purchase and financing of the forklift, XYZ signs a conditional sales agreement with ABC. XYZ's payments under the agreement are calculated as follows:

5. Under the terms of the conditional sales agreement, possession of the forklift is transferred to XYZ on January 1, 1998 (date of agreement).

2. The XXXXX on GST payable on the sale of the forklift is remitted on ABC's return for the period ending January 31, 1998.

3. On December 1, 1998, XYZ fails to remit its monthly payment of $XXXXX [t]o ABC. On June 1, 1999, ABC determines that the amount owing from XYZ is a bad debt and is not collectible. XYZ's debt is written off ABC's books of account on June 1, 1999.

Interpretation Requested

In relation to the facts presented, you have asked the following questions:

1. Does Revenue Canada view the conditional sales agreement as two distinct transactions - one being the sale of the forklift and the other being the granting of credit to XYZ?

2. Is ABC entitled to recover GST on the portion of the bad debt written off (i.e[.] of $XXXXX under subsection 231(1) of the Excise Tax Act (Act)?

Interpretation Given

Based on the information provided, our comments are as follows:

1. Yes - there are two supplies. A sample conditional sales contract was not provided. It is assumed, however, that the contract separates the supply of the forklift from the supply of financial services. On this understanding, an agreement which constitutes a sale but where the payments are made on an installment basis and include a financing component, such as in a conditional sales contract, the financing charges are not subject to GST/HST. Financing charges are an exempt supply since they represent a financial service, as the term is defined in subsection 123(1) of the Act. Financing charges are either interest, or an amount payable in respect of a financial instrument. When shown and charged separately from other charges contained in the details of the transaction, they are not subject to either the incidental supply rule contained in section 138 of the Act or the mixed supply rule contained in section 139 of the Act.

2. No - the total amount of the receivable written off as a bad debt is not, in the case of GST, multiplied by 7/107 (tax fraction). Subsection 231(1) of the Act states that, where a person has made a taxable supply for consideration and, has remitted the tax, and at a later time determines that the consideration and tax have become, in whole or in part, a bad debt, the person may deduct an amount equal to the tax fraction of the bad debt written off in the books of account. If the bad debt includes a financing charge, the amount of GST/HST written off would be inflated.

Explanation

Financing - Where financing has been arranged for the acquisition of a forklift and the debtor defaults on the payments, the registrant is only entitled to claim an amount under subsection 231(1) of the Act equal to the tax fraction of the consideration for the forklift. Any consideration included for financing the purchase, such as interest, would have to be removed before the tax fraction is applied. Therefore, where a bad debt includes consideration for more than one supply, and one or more of the supplies is exempt, the person claiming the bad debt deduction is required to remove that portion of the consideration relating to the exempt supply before determining the tax content of the bad debt. This is particularly relevant in the case of a conditional sale, where a financing charge may be buried in the monthly amount that was payable by the debtor and subsequently became a bad debt.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretation provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Department with respect to a particular situation.

For your convenience, find enclosed a copy of section 1.4 of Chapter 1 of the GST/HST Memoranda Series.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-7931.

Yours truly,

David Crawford
General Operations Unit
General Operations and Border Issues Division
GST/HST Rulings and Interpretations Directorate

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